AUDITING & ASSURANCE PRINCIPLES
AT.109-Materiality and Risks
LECTURE NOTES
Concept of Materiality
The auditor is expected to design and conduct an audit
that provides reasonable assurance that material
misstatements will, whether due to fraud or error, be
detected.
The auditor is required to determine materiality for the
financial statements as a whole when establishing the
overall audit strategy, which is part of planning an audit.
In financial reporting, materiality is any information that
may influence user’s economic decisions. On the other
hand, materiality in audit is considered in terms of the
smallest aggregate level of misstatements that could be
considered material to any one of the statements that
comprise the financial statements.
For any given client, materiality is not simply a function of
specific amounts in the financial statements. An auditor
must understand who the potential users are and the type
of judgments made by those users when relying on
financial statements.
Application of Materiality
Materiality is applied both in planning, performing and
concluding on the audit. In particular, when:
• Identifying material classes of transactions, account
balances and disclosures
• Determining the nature, timing and extent of risk
assessment procedures
• Identifying and assessing the risks of material
misstatement
• Determining the nature, timing and extent of further
audit procedures (testing of controls and performing
substantive procedures)
• Evaluating the effect of uncorrected misstatements, if
any, on the financial statements and in forming the
opinion in our audit report.
Materiality Levels
The auditor establishes the following levels of materiality in
an audit of financial statements:
a. Materiality for the financial statements as a whole
b. Materiality for particular classes of transactions,
account balances, or disclosures, if necessary
c. Performance materiality for (a) and (b) above
d. Clearly trivial materiality
Materiality for the Financial Statements as a whole
(a.k.a. Preliminary/Planning Materiality)
The auditor’s determination of materiality is a matter of
professional judgment, and is affected by the auditor’s
perception of the financial information needs of users of
the financial statements. The determination of materiality
is not a mechanical exercise, if fact, there is no specific
methodologies prescribed in the standard. However, a
percentage is often applied to a chosen benchmark as a
starting point to determine materiality. Qualitative
conditions should also be considered in determining
materiality.
Benchmarks
Factors that may affect the identification of an appropriate
benchmark include:
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• The elements of the financial statements (e.g., assets,
liabilities, equity, revenue, expenses)
• Whether there are items on which the attention of the
users of the particular entity’s FSs tends to be focused
• The nature of the entity, where the entity is in its life
cycle, and the industry and economic environment in
which the entity operates
• The entity’s ownership structure and the way it is
financed
• The relative volatility of the benchmark.
Profit before tax from continuing operations is often used
for profit-oriented entities.
Materiality for Particular Classes of Transactions,
Account Balances, or Disclosures
For certain entities, there may be one or more particular
classes of transactions, account balances, or disclosures
for which misstatements of lesser amounts than
materiality for the financial statements as a whole could
reasonably be expected to influence the economic
decisions of users taken on the basis of the financial
statements.
Factors that may indicate such classes of transactions,
account balances, or disclosures exist include the
following:
• Whether law, regulation or the applicable financial
reporting framework affect users’ expectations
regarding the measurement or disclosure of certain
items (e.g., related party transactions, and the
remuneration of management and those charged with
governance)
• The key disclosures in relation to the industry in which
the entity operates (e.g., research and development
costs for a pharmaceutical company)
• Whether attention is focused on a particular aspect of
the entity’s business that is separately disclosed in the
financial statements (e.g., a newly acquired business).
Performance Materiality (a.k.a. Tolerable
Misstatement)
Performance materiality is the amount or amounts set by
the auditor at less than materiality for the FSs as a whole
to reduce to an appropriately low level the probability that
the aggregate of uncorrected and undetected
misstatements exceeds materiality for the FSs as a whole,
i.e., to provide a cushion, so that if misstatements are
detected, the auditor may nevertheless be able to conclude
with reasonable assurance that the total misstatement in
the FSs does not exceed materiality.
The auditor is required to determine performance
materiality for purposes of:
• assessing the risks of material misstatement; and
• determining the nature, timing, and extent of further
audit procedures.
If materiality level(s) have been set for particular classes
of transactions, account balances, or disclosures,
performance materiality also refers to amount(s) set at
less than these levels
Clearly trivial materiality
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.
Clearly trivial materiality is the amount below which
misstatements would be clearly trivial and would not need
to be accumulated because such amounts clearly would
not have a material effect on the financial statements.
When there is any uncertainty about whether one or more
items are clearly trivial, the matter is considered not to be
clearly trivial.
Revision of Materiality
Materiality levels are not cast in stone once determined.
These may be adjusted, upward or downward, as
necessary as the audit progresses for example:
• Changes in entity’s circumstances
• New information
• Change in understanding of entity and its operations
Documentation of Materiality
The auditor shall document the following:
• Materiality for financial statements as a whole
• Materiality level(s) for particular items
• Performance materiality for the above
• Revisions to the above as the audit progresses
Materiality and Audit Procedures
The level of materiality has an inverse relationship on audit
procedures. The lower the materiality (performance
materiality), the more extensive the required audit
procedures to be able to gain reasonable assurance that
the class of transactions, account balance, or disclosure is
not materiality misstated.
Identifying Material Classes of Transactions, Account
Balances and Disclosures
The auditor, after determining materiality and gaining
sufficient understanding of the entity and its environment
including internal control, identifies material classes of
transactions, account balances and disclosures from the
entity trial balance, list of accounts and notes to financial
statements.
By identifying these items, the auditor focuses the audit
only on what is deemed material, thereby reduces its work
on what is determined not to be material.
The auditor applies its professional judgment and should
consider both the account’s nature and amount,
quantitatively and qualitatively, in deciding whether an
account is material or not. Quantitative consideration may
involve comparison of an account’s amount with the
materiality previously determined. If an account’s amount
exceeds materiality, this may be considered material.
However, there are accounts that may not be
quantitatively material but may deemed material
qualitatively, such as those accounts involving accounting
estimates (e.g., allowance for doubtful accounts,
retirement obligations, etc.) or suspicious account
(miscellaneous accounts, related party transactions).
Types of Risk
The four critical components of risk that will affect the
audit approach and audit outcome are:
1. Business Risk – the risk that affects the operations and
potential outcomes of the entity’s organizational
activities.
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2. Financial Reporting Risk – the risk that relates to the
recording of transactions and the presentation of
financial data in an entity’s financial statements.
3. Audit Risk/Audit Engagement Risk – the risk that the
auditor may provide an unqualified opinion on financial
statements that are materially misstated.
4. Other Audit Engagement Risk – the risk auditors
encounter by being associated with a particular client:
loss of reputation, inability of the client to pay the
auditor, or financial loss because management is not
honest and inhibits the audit process.
Audit Risk and The Audit Risk Model
Audit risk is the risk (likelihood) that the auditor gives an
inappropriate audit opinion when the FSs are materially
misstated. Audit risk is a function of the risks of material
misstatement and detection risk [AR = f(ROMM x DR)].
Risks of Material Misstatement (ROMM)
The ROMM refers to the likelihood that the financial
statements are materiality misstated prior to the audit.
The ROMM may exist at two levels:
• The overall financial statement level; and
• The assertion level for classes of transactions, account
balances, and disclosures.
ROMM at the overall FSs level refer to risks of material
misstatement that relate pervasively to the FSs as a whole
and potentially affect many assertions.
ROMM at the assertion level are assessed in order to
determine the nature, timing, and extent of further audit
procedures (test of controls and substantive procedures)
necessary to obtain sufficient appropriate audit evidence.
The risks of material misstatement at the assertion level
consist of two components: inherent risk and control risk.
Therefore, at the assertion level, audit risk can be
expressed through this model AR = f(IR x CR x DR).
Inherent risk and control risk (if the auditor does not
intend to rely on the entity’s internal control, hence control
risk will be assessed as high) can be assessed through
risks assessment procedures. Control risk can also be
assessed by performing test of controls, i.e., if the auditor
intends to rely on effectiveness of the entity’s internal
control. In this case control is may be assessed as low if
the control are found effective, otherwise, it would still be
assessed as high. After assessing the levels of ROMM, the
auditor determines the acceptable level of detection risk.
Control Risk
Control risk is the risk that a misstatement that could
occur in an assertion about a class of transaction, account
balance or disclosure and that could be material, either
individually or when aggregated with other misstatements,
will not be prevented, or detected and corrected, on a
timely basis by the entity’s internal control.
Control risk is a function of the effectiveness of the design,
implementation and maintenance of internal control.
However, internal control, no matter how well designed
and operated, can only reduce, but not eliminate, risks of
material misstatement in the financial statements, because
of the inherent limitations of internal control. Accordingly,
some control risk will always exist.
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.

Inherent risk
Inherent risk is the susceptibility of an assertion about a
class of transaction, account balance or disclosure to a
misstatement that could be material, either individually or
when aggregated with other misstatements, before
consideration of any related controls (i.e., assuming that
there were no related internal controls.)
Inherent risk is higher for some assertions and related
classes of transactions, account balances, and disclosures
than for others. For example, it may be higher for complex
calculations or for accounts consisting of amounts derived
from accounting estimates that are subject to significant
estimation uncertainty. External circumstances giving rise
to business risks may also influence inherent risk. For
example, technological developments might make a
particular product obsolete, thereby causing inventory to
be more susceptible to overstatement.
Limitations of Audit Risk Model
The audit risk model has the following limitations:
• Inherent risk is difficult to formally assess.
• Audit risk is judgmentally determined.
• The model treats each risk component as separate and
independent when in fact the components are not
independent.
• Audit technology is not so precisely developed that
each component of the model can be accurately
assessed.
Because of these limitations, many auditors use the audit
risk model as a functional one, rather than mathematical
model
Risks of Material Misstatements, Detection Risk and
Audit Procedures

Inherent risk and control risk are the entity’s risks; they
exist independently of the audit of the financial
statements. Normally, the auditor combines the
assessment of inherent risk and control risk known as the
environment risk or combined risk assessment.
The higher the assessed level of risk of material
misstatement, the lower the detection risk the auditor
sets, and vice versa. The lower the detection risk, the
more rigorous (nature, timing and extent) the substantive
audit procedures should be performed, and vice versa.

Detection Risk
In summary:
Detection risk is the risk that the procedures performed by
the auditor to reduce audit risk to an acceptably low level Substantive Assessed level of Assessed level of
will not detect a misstatement that exists and that could Audit procedures ROMM is high ROMM is low
be material, either individually or when aggregated with Nature More effective Less effective
other misstatements. Timing At year end At interim dates
Extent More extensive Less extensive
For a given level of audit risk, the acceptable level of
detection risk bears an inverse relationship to the assessed Audit Risk and Materiality
risks of material misstatement at the assertion level. The
higher the assessed level of risk of material misstatement, There is an inverse relationship between materiality and
the lower the detection risk the auditor sets, and vice the level of audit risk, i.e., the higher the materiality, the
versa. lower the audit risk, and vice versa. The auditor takes the
inverse relationship between materiality and audit risk into
Detection risk relates to the nature, timing, and extent of account when determining the nature, timing and extent of
the auditor’s procedures that are determined by the audit procedures.
auditor to reduce audit risk to an acceptably low level. It is
therefore a function of the effectiveness of an audit Materiality and Audit Evidence
procedure and of its application by the auditor.
Materiality and audit evidence are inversely related. The
Therefore, from the given relationship above, detection lower the level of materiality the auditor determines, the
risk cannot be set to zero (given that there is always risk more audit evidence must be obtained (and vice versa) in
of material misstatement). This is also because of many order to gain more confidence (assurance) that the item is
factors in audit such as sampling risk (remember, the not materiality misstated.
auditor does not examine the entire transactions and
account balances) and human error. - done -

MULTIPLE CHOICE
Concept and Application of Materiality
1. In audit of financial statements, it is considered in
terms of the smallest aggregate level of misstatements
that could be considered material to any one of the
statements that comprise the financial statements,
while in financial reporting, it provides a threshold or
cutoff point rather than being a primary qualitative
characteristic which information must have if it is to be
useful
a. Materiality
b. Reliability
3. The preliminary judgment about materiality is the
c. Relevance
d. Misstatement
2. In considering materiality for planning purposes, an
auditor believes that misstatements aggregating
P100,000 would have a material effect on an entity’s
income statement, but that misstatements would have
to aggregate P200,000 to materially affect the balance
sheet. Ordinarily, it would be appropriate to design
auditing procedures that would be expected to detect
misstatements that aggregate
a. P100,000
b. P150,000
c. P200,000
d. P300,000
_________ amount by which the auditor believes the
statements could be misstated and still not affect the
decisions of reasonable users.
a. Minimum

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 b. Maximum
c. Mean average
d. Median average
4. Auditors are _____ to decide on the combined amount
of misstatements in the financial statements that they
would consider material early in the audit.
a. Permitted
b. Required
c. Not allowed
d. Strongly encouraged
5. Financial reporting frameworks often discuss the
concept of materiality in the context of the preparation
and presentation of financial statements. Although
financial reporting frameworks may discuss materiality
in different terms, they generally explain that
a. Misstatements, including omissions, are considered
to be material if they, individually or in the
aggregate, could reasonably be expected to
influence the economic decisions of users taken on
the basis of the financial statements
b. Judgments about materiality are made in the light
of surrounding circumstances, and are affected by
the size or nature of a misstatement, or a
combination of both
c. Judgments about matters that are material to
users of the financial statements are based on a
consideration of the common financial information
needs of users as a group. The possible effect of
misstatements on specific individual users, whose
needs may vary widely, is not considered.
d. All of the above
6. Only the amount of misstatements need to be
considered in assessing materiality.
Both the amount and nature of misstatements need to
be considered in assessing materiality.
a. True, True c. False, False
b. False, True d. True, False
FSs Level Materiality
7. Which of the following is not true about materiality
judgment?
a. The auditor’s consideration of materiality is
influenced by the auditor’s perception of the needs
(importance) of users of financial statements.
b. The auditor considers materiality only in relation to
classes of transactions, account balances, and
disclosures.
c. Materiality judgments make sure that the auditor
gathers sufficient evidential matter to obtain
reasonable assurance about whether the financial
statements are free of material misstatement.
d. Materiality decisions differ from one audit client to
another.
8. Determining a materiality level for the financial
statements as a whole requires the exercise of
professional judgment. A percentage is often applied to
a chosen benchmark as a starting point in that
determination. Factors that may affect the
identification of an appropriate benchmark include the
following:
a. The elements of the financial statements (e.g.,
assets, liabilities, equity, income, expenses)
b. Whether there are items on which the attention of
the users of the particular entity’s financial
statements tends to be focused (e.g., for the
purpose of evaluating financial performance users
may tend to focus on profit, revenue or net
assets);
c. The nature of the entity, where the entity is at in
its life cycle, and the industry and economic
environment in which the entity operates;
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d. All of the above
9. Which of the following would an auditor most likely use
in determining the auditor’s preliminary judgment
about materiality?
a. The anticipated sample size of the planned
substantive tests
b. The entity’s annual financial statements
c. The results of the internal control questionnaire
d. The contents of the management representation
letter
10. Which of the following is least likely to be appropriate
as the basis for determining the preliminary judgment
about materiality in the audit of financial statements?
a. Net income before taxes
b. Current assets
c. Owners’ equity
d. Inventory
11. Why do auditors establish a preliminary judgment
about materiality?
a. To determine the appropriate level of audit
experience required for the work.
b. So that the client can know what records to make
available to the auditor.
c. To plan the appropriate audit evidence to
accumulate and develop an overall audit
strategy.
d. To finalize the assessment of control risk.
Performance Materiality/Tolerable Misstatement
12. Materiality should be considered by the auditor when
a. Determining the nature, timing and extent of
auditor’s further procedures
b. Identifying and assessing the risks of material
misstatements
c. Both a and b
d. Neither a nor b
13. When auditors allocate the preliminary judgment about
materiality to account balances, the materiality
allocated to any given account balance is referred to
as:
a. The materiality range
b. The error range
c. Tolerable materiality
d. Tolerable misstatement
14. Auditors commonly allocate materiality to balance
sheet accounts rather than income statement accounts
because most income statement misstatements have
a(n) _____ effect on the balance sheet.
a. Reduced
b. Equal
c. Undetermined
d. Increased
Revision and Documentation of Materiality
15. The materiality level for the financial statements as a
whole (or the materiality level for a particular class of
transactions, account balance or disclosure, if
applicable) may need to be revised (adjusted either
downward or upward) as a result of the following
a. a change in circumstances that occurred during the
audit
b. new information
c. a change in the auditor’s understanding of the
entity and its operations as a result of performing
further audit procedures.
d. all of the above
16. Under which of the following conditions would you
consider lowering individual item materiality
thresholds.
AT.109
 a. Study of the business and industry, together with
the application of analytical procedures, reveals
that the client has enjoyed a surge in sales and
gross profit during an industry downturn.
b. Application of analytical procedures shows that the
client's gross profit rate is significantly below last
year and also is materially lower than the industry
average.
c. Study of internal controls within the revenue cycle
reveal material weaknesses.
d. Study of internal controls within the payroll cycle
confirm the auditor's belief that few errors have
occurred.
17. Auditing standards _____ that the basis used to
determine the preliminary judgment about materiality
be documented in the audit files.
a. Permit
b. Do not allow
c. Require
d. Strongly encourage
Relationships to Materiality
18. If an auditor establishes a relatively high level for
materiality, then the auditor will:
a. accumulate more evidence than if a lower level had
been set.
b. accumulate less evidence than if a lower level had
been set.
c. accumulate approximately the same evidence as
would be the case were materiality lower.
d. accumulate an undetermined amount of evidence.
19. Which of the following statements concerning
materiality thresholds is incorrect?
a. Aggregate materiality thresholds are a function of
the auditor's preliminary judgments concerning
audit risk.
b. In general, the more misstatements the auditor
expects, the higher should be the aggregate
materiality threshold.
c. The smallest aggregate level of errors or fraud that
could be considered material to any one of the
financial statements is referred to as a "materiality
threshold."
d. Materiality thresholds may change between the
planning and review stages of the audit. These
changes may be due to quantitative and/or
qualitative factors.
20. Why should the auditor plan more work on individual
accounts as lower acceptable levels of both audit risk
and materiality are established?
a. To find smaller errors.
b. To find larger errors.
c. To increase the tolerable error in the accounts.
d. To decrease the risk of overreliance.
Risks
21. In the audit risk model, which of the risk components
can be assessed by the auditor?
a. Inherent risk.
b. Control risk.
c. Detection risk.
d. Both A and B.
22. In the audit risk model, its risk components are either
determined, assessed, or manipulated. Which of the
following risks are controllable by the auditor?
a. Audit risk.
b. Control risk.
c. Detection risk.
d. Both A and C.
23. Which of the following statements is not true regarding
audit risk assessment?
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a. The auditor studies the business and industry and
applies analytical procedures as a basis for
assessing inherent risk.
b. When control risk and inherent risk are high, the
auditor increases detection risk to maintain overall
audit risk at the desired level.
c. The auditor studies and evaluates internal control
policies and procedures for assessing control risk.
d. The auditor designs substantive audit procedures
to reduce detection risk to an acceptable level.
24. Which of the following audit risk components may be
assessed in nonquantitative terms?
Control risk Detection risk Inherent risk
a. Yes Yes Yes
b. No Yes Yes
c. Yes Yes No
d. Yes No Yes
25. Assume that control risk = 0.70, inherent risk = 0.80,
and audit risk = 0.05. If a material misstatement
occurred and was not corrected by the auditee’s
internal controls, what is the risk that the
misstatement would not be detected by the audit
procedures?
a. 0.02
b. 0.07
c. 0.09
d. 0.50
26. Which of the following best describes the relationship
between IR, CR, and DR?
a. DR does not vary from one assertion to another.
b. IR, CR, and DR vary from assertion to assertion.
c. IR and CR do not vary from assertion to assertion,
but DR does vary from assertion to assertion.
d. When IR increases, DR decreases.
27. Which of the following statements is not true?
a. Inherent risk is inversely related to detection risk.
b. Inherent risk is inversely related to evidence.
c. Inherent risk is the susceptibility of the financial
statements to material error, assuming no internal
controls.
d. Inherent risk is the auditor’s assessment of the
likelihood that errors exceeding a tolerable amount
exist in a segment before considering the
effectiveness of internal controls.
28. Inherent risk is often low for an account such as:
a. inventory.
b. marketable securities.
c. cash.
d. accounts receivable.
29. Audit risk consists of inherent risk, control risk, and
detection risk. Which of the following statements is
true?
a. Cash is more susceptible to theft than an inventory
of coal because it has a greater inherent risk.
b. The risk that material misstatement will not be
prevented or detected on a timely basis by internal
control can be reduced to zero by effective
controls.
c. Detection risk is a function of the efficiency of an
auditing procedure.
d. The existing levels of inherent risk, control risk,
and detection risk can be changed at the discretion
of the auditor.
30. Inherent risk and control risk differ from detection risk
in that inherent risk and control risk
a. arise from the misapplication of auditing
procedures
b. may be assessed in either quantitative or
nonquantitative terms
AT.109
 c. exist independently of the financial statement audit will not detect a misstatement that exists in an
d. can be changed at the auditor’s discretion account balance or class of transactions that could
be material, individually or when aggregated with
31. Which of the following is an incorrect statement?
misstatements in other balances or classes.
a. Detection risk cannot be changed at the auditor’s
d. The susceptibility of an account balance or class of
discretion
transactions to misstatement that could be
b. Detection risk bears an inverse relationship to
material, individually or when aggregated with
inherent and control risks
misstatements in other balances of classes,
c. The greater the inherent and control risks the
assuming that there were no related internal
auditor believes exists, the less detection risk that
controls.
can be accepted
d. The auditor might separate or combined 34. Which is a primary limitation of the audit risk model?
assessments of inherent risk and control risk a. The audit risk model does not adequately consider
external forces on the client organization.
32. When discussing control risk (CR) and the audit risk
b. Components of audit risk are treated as
model, which of the following is false?
independent variables even though many
a. CR is a measure of the auditor’s assessment of the
interdependencies exist between them.
likelihood that misstatements will not be prevented
c. The audit technology achieves approximate
or detected by internal control.
precision outside of a mathematical model.
b. If the auditor concludes that internal control is
d. Control risk must be adjusted at the hands of the
completely ineffective to prevent or detect errors,
auditor, not by an arbitrary estimation.
he/she would assign a low value (e.g., 0%) to CR.
c. The relationship between control risk and detection 35. Which of the following statements is true with regard
risk is inverse. to the relationship among audit risk, audit evidence,
d. The relationship between control risk and evidence and materiality?
needed to support account balances is direct. a. The lower the inherent risk and control risk, the
lower the aggregate materiality threshold.
33. Detection risk is
b. Under conditions of high inherent and control risk,
a. The risk that the auditor gives an inappropriate
the auditor should place more emphasis on
audit opinion when the financial statements are
obtaining external evidence and should reduce
materially misstated.
reliance on internal evidence.
b. The risk that a misstatement, that could occur in
c. Where inherent risk is high and control risk is low,
an account balance or class of transactions and
the auditor may safely ignore inherent risk.
that could be material individually or when
d. Aggregate materiality thresholds should not
aggregated with misstatements in other balances
change under conditions of changing risk levels.
or classes, will not be prevented or detected and
corrected on a timely basis by the accounting and
- now do the DIY drill -
internal control systems.
c. The risk that an auditor's substantive procedures

DO-IT-YOURSELF (DIY) DRILL

1. The probability of an auditor's procedures leading to
the conclusion that a material error does not exist in
an account balance when, in fact, such error does exist
is referred to as
a. Prevention risk.
b. Inherent risk.
c. Control risk.
d. Detection risk.
2. When discussing control risk (CR) and the audit risk
model, which of the following is false?
a. CR is a measure of the auditor’s assessment of the
likelihood that misstatements will not be prevented
or detected by internal control.
b. If the auditor concludes that internal control is
completely ineffective to prevent or detect errors,
he/she would assign a low value (e.g., 0%) to CR.
c. The relationship between control risk and detection
risk is inverse.
d. The relationship between control risk and evidence
needed to support account balances is direct.
3. Materiality is least important to an external auditor in
determining the:
a. Effect on independence of his direct financial
interest in the client
b. Extent of his audit of certain accounts
c. Effects of exceptions upon his opinion in the audit
report
d. Specific transactions which should require a
detailed review
4. Materiality is:
a. Addressed within a practitioner’s audit and other
assurance reports
b. Expressed only in terms of pesos
c. Measured using guidelines established by PICPA
d. Not applicable to assurance engagements
5. Materiality thresholds for accounting errors should be
established for each financial statement element.
However, they
a. Must require correction of accounting errors in the
subsequent year’s records.
b. Lead to rejection of financial statements found with
unrecorded accounting records.
c. Tend to hamper objectivity of auditor’s judgment
concerning severity of errors.
d. Must be established prior to execution of audit
procedures.
6. Since materiality is relative, it is necessary to have
bases for establishing whether misstatements are
material. Normally, the most common base for
deciding materiality is:
a. Net income before taxes
b. Net working capital
c. Net income after taxes
d. Total assets
7. Which of the following elements of the audit risk model
is most likely to be the same across a range of audits
performed by a professional accounting firm?
a. Audit risk
b. Control risk

Page 6 of 7 AT.109
 c. Detection risk d. Statement of cash flows.
d. Inherent risk
15. Engagement risk has been defined as the risk of
8. Which of the following statements is not correct?
potential losses that are incurred by the auditor in
a. Materiality is a relative rather than an absolute
being associated with a particular client. Which of the
concept.
following factors are not associated with increased
b. The most important base used as the criterion for
engagement risk for the auditor?
deciding materiality is total assets.
a. Management with questionable integrity.
c. Qualitative factors as well as quantitative factors
b. A failed company.
affect materiality.
c. Materially misstated financial statements.
d. Given equal amounts, frauds are usually
d. All of these factors increase engagement risk.
considered more important than errors.
16. In implementing the audit risk model, which of the
9. The preliminary judgment about materiality and the
following is not a limitation of the model that makes its
amount of audit evidence accumulated are _____
implementation difficult?
related.
a. Inherent risk is difficult to formally assess.
a. Directly
b. Audit risk is objectively determined.
b. Indirectly
c. The model treats each risk component as separate
c. Not
and independent.
d. Inversely
d. Audit technology is not precisely developed in
10. Which of the following statements is correct concerning assessing each component.
the concept of materiality?
17. Residual risk is defined as
a. Materiality is determined by reference to PICPA
a. susceptibility of a transaction or accounting
guidelines
adjustment to be recorded in error, or for the
b. Materiality depends only on the peso amounts of
transaction not to be recorded in the absence of
an item relative to other items in the financial
internal controls.
statements
b. the risk that the client’s internal controls system
c. Materiality depends on the nature of an item rather
will fail to prevent or detect a misstatement.
than the peso amount
c. the risk left in an account balance after application
d. Materiality is a matter of professional judgment
of internal controls.
11. In determining audit risk, the auditor decides how d. risk that the audit procedures will fail to detect a
much risk will be taken on by the firm. Which of the material misstatement.
following is correct regarding this decision by the
18. Madison Corporation has a few large accounts
auditor?
receivable that total P1,000,000. Nass Corporation
a. The auditor may decide to intentionally render an
has a greater number of small accounts receivable that
inappropriate opinion.
also total P1,000,000. The importance of an error in
b. The auditor may decide not to take the audit
any one account is, therefore, greater for Madison than
engagement.
for Nass. This is an example of the auditor’s concept
c. The auditor may decide to accept audit risk at
of
100%.
a. Materiality
d. The auditor may decide that engagement risk is an
b. Comparative analysis
appropriate measure of audit risk.
c. Relative risk
12. Auditors frequently refer to the terms audit assurance, d. Reasonable assurance
overall assurance, and level of assurance to refer to
________. 19. Regardless of how the preliminary judgment about
a. detection risk materiality is allocated, the auditor must be confident
b. audit report risk that total combined misstatements in all accounts are:
c. acceptable audit risk a. Less than the preliminary judgment.
d. inherent risk b. Equal to the preliminary judgment.
c. More than the preliminary judgment.
13. Inherent risk is _______ related to detection risk and d. Less than or equal to the preliminary judgment.
_______ related to the amount of audit evidence.
a. directly, inversely 20. What is the primary difference between financial
b. directly, directly reporting risk and audit risk?
c. inversely, inversely a. The application of accounting principles.
d. inversely, directly b. Responsibilities of the respective parties involved.
14. Auditors generally allocate the preliminary judgment c. Demands of users of financial statements.
about materiality to the: d. Risks of being sued by third parties.
a. Balance sheet only.
b. Income statement only. ☺ - end of AT.109 - ☺
c. Income statement and balance sheet.

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